INVESTMENT EXTRA: Glencore and Xstrata tie-up is rife with risks

Much has been made of the global powerhouse that the £50billion merger between Glencore and Xstrata would create, assuming it goes ahead.

The proposition certainly bears all the hallmarks of a money-printing machine.
Xstrata is very good at operating mines (like the one pictured, right, in Australia) efficiently and at low cost, without upsetting local communities. Glencore is not.

But it does boast a global network of commodities traders who possess unrivalled intelligence on global demand trends that theoretically allows them to make money at any stage of the commodity cycle.

Potential pitfalls: If the Glenstrata merger goes ahead, there could be a major exodus of staff loyal to Mick Davis, who steps aside for Ivan Glasenberg as part of this deal

Combining the two – in a
first-of-its-kind ‘vertically integrated’ commodities player – should
allow Xstrata to feed its cheaply-sourced metals into Glencore’s trading
machine.

The two firms, both based in the
low-tax Swiss canton of Zug, expect to make £311million in synergies per
year and will certainly dominate a number of key metals markets.

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The logic has convinced plenty of
City scribblers. Liberum Capital painted a rather rosy picture of the
mining sector landscape in a post-Glenstrata world last month. The
merged company, they said, ‘delivers best earnings growth in favoured
commodities’.

They reckon Xstrata’s cash generation will prop up Glencore’s credit rating by reducing leverage.
The hypothetical stock is rated a ‘Buy’.

At Jefferies, they expect ‘industry
leading dividend growth leading to a premium equity valuation’, as well
as the firepower to make lucrative acquisitions.

But they also point out the risks –
and they are legion: ‘The merged company would still have high financial
leverage and high earnings sensitivity to changes in commodity prices.’

There are other potential pitfalls,
not least a major exodus of staff loyal to Mick Davis, who steps aside
for Ivan Glasenberg as part of this deal.

Xstrata’s greatest strength is its
people, who have turned a company that was, ironically, carved out of
Glencore into one of the most respected mining firms in the world.

The way Glasenberg has conducted
himself throughout this merger, playing the hard-nosed wheeler-dealer
role, does not speak of a man likely to brook much opposition in the
boardroom.

As one top 20 Xstrata investor told
the Mail this week: ‘The idea that non-executives are going to stand up
to Glasenberg in the boardroom doesn’t sound very likely.’

Speculation is also mounting that a merged firm would make a tilt at
fellow miner Anglo American. That sort of aggressive strategy could
bring great rewards, but also carries significant risk.

Underlying all of this is the
unspoken and intangible risk that so much of the City wants this deal –
and the advisory associated fees – that analysts have merely smiled and
nodded rather than engaging their critical faculties.

The few naysayers out there have
pointed to a dynamic that doesn’t get talked about much. Miners rely, to
a large degree, on China’s appetite for growth and they have invested
heavily to satisfy it.
Many of those projects are only now coming on stream, just as China’s
growth is not only cooling, but moving into a different phase.

The People’s Republic will continue
to build infrastructure and buildings, but has completed much of this
work and is now likely to focus more on the consumer goods and service
industries that have come to dominate more mature economies. Those activities swell demand for skilled people and technology much more than they do for raw materials.

As things stand, most people expect
this merger to get done. But the greatest unknown factor is the casting
vote of Qatar Holdings, whose silence so far speaks volumes.

Qatar liked Xstrata as a stand-alone company but has shown less enthusiasm for Glenstrata.

Norges Bank, Xstrata’s third-largest
investor, is also thought to be ready to sell out because it does not
want Glencore shares.

Since Glencore floated its shares
have declined by 37 per cent, worse than the 32.5 per cent fall seen at
Xstrata. Those of a risk-averse persuasion may not see why that sort of
performance offers a better bet than Xstrata.

Hemsley cashes shares

Shares in Numis Corporation have enjoyed a good run of late, which may help explain why chief executive and founder Oliver Hemsley decided to cash in some of his investment in the AIM-listed stockbroker. He got a price of 99p per share, meaning he banked a total of £1.5million.

Numis has around 140 UK companies as corporate clients, of which 26 are in the FTSE 250.
It is predicting significant growth in revenues in the second half of the year thanks to business generated from deal-making. It employs around 190 people.